Market failure Flashcards
What is a third party?
Someone other than the buyer and seller who bears the consequences of economic activity
What is an externality?
A cost or benefit that affects a third party
What is an external cost?
Costs impacting third parties
What are external benefits?
Gains which impact third parties
What are private benefits?
A buyer’s gains from the consumption of goods and services
What are private costs?
The costs paid by the supplier of a good or service
What does the free market ignore?
External costs and benefits
What are social costs?
The total of private costs and any external costs
What are social benefits?
The total of private benefits and any external benefits
When does overconsumption and overproduction occur?
When prices reflect only the private costs of production, ignoring the external costs
How can we determine whether an economic activity is worthwhile overall?
By calculating whether the social benefits outweigh the social costs
Explain how the free market fails to account for external costs harming third parties?
These costs will not be reflected in the price of the product. People will buy more than they would if the price was based on social cost. This will lead to overconsumption and overproduction
Why is the price mechanism a limited model?
It only works efficiently if there is genuine competition between producers. In some sectors of the economy, certain businesses can hold a monopoly of market power. By producing less, they can push up the price of a product. Buyers will pay more for it than they would in a competitive market
What is the problem with using the free market to supply important products, like healthcare?
They will not be provided by the market in adequate quantities to meet the needs of everyone
When do underconsumption and underproduction occur?
When less is produced than would be optimal for society as a whole, given the external benefits of the product
